Unhappy Forecasts: Iraq's Future Oil Plagued by Problems

Estimated to have one of the largest oil reserves in the world, Iraq could be the major player in the world's oil industry. But up until now, things have not been going as well as expected. So what's the problem?

There is no doubt that Iraq has the potential to be one of the globe's leading oil exporters. The country's conventional oil reserves could match, or even surpass, that of Saudi Arabia, currently the second largest oil exporter in the world. Over half of Iraq's potential remains undiscovered and there will be a tremendous amount of interest in the country's oil for years to come.

However Iraq faces major challenges to the future of its oil industry. Superficially things look okay: daily production is just below 3million barrels per day and capacity is rising. Oil income has risen a whopping 60% but this is due more to high oil prices. In fact production only went up by 15% important issue, some of them exploit it for the purposes of political point scoring.

In order for Iraq to become the oil exporting power it has the potential to be in the future, the following issues will need to be resolved.

The Oil and Gas Law
The first draft of a national oil and gas law was put together in 2006 and 2007. But before the law even got its first reading in Parliament, the draft began to be tampered with. And eventually the law became so political that it became difficult to make any sense of it. The law became unworkable and the first attempt to legislate the sector failed. As such, it reflected the dysfunctional nature of Iraqi politics.

An election, further attempts at lawmaking and various regional disputes later and the current government has still failed to come up with a workable compromise on the oil and gas law. Several versions now exist, formulated by different branches of the government, but so far there has been no progress on an all-important law to regulate a vital sector that Iraq's economy is almost completely reliant upon.

Infrastructure Issues
Oil industry infrastructure has suffered from chronic under investment since the early 1980s. Three wars, civil unrest and poor management within the sector has left infrastructure in dire conditions. Serious investment is needed.

Today the presence of major international oil companies in the south of the country - some of whom are busy developing Iraq's infrastructure - is not due to sound policies. Rather it's due to the fact that Iraq has vast oil reserves that the oil companies cannot ignore.

It is true that oil production is on the rise. Iraq clocked 790.5 million barrels of oil in 2011, raising almost $83 billion in revenues. In 2010, Iraq sold 689.9 million barrels for US$52.2 billion in revenues. However given the fact that international sanctions against Iraq were lifted almost nine years ago, following the toppling of former Iraqi leader Saddam Hussein, current production is nowhere near the level it could be at.

As new wells come on line, capacity is increasing. But bottlenecks created by run down infrastructure, including pipelines and storage facilities, and a lack of investment affect production levels. Earlier targets were wildly optimistic: around 12 million barrels per day by 2017. And slowly but surely Baghdad has been decreasing these targets. The current aim is 7million barrels per day by 2017.

Regional Disputes
Since 2003, the semi-autonomous region of Iraqi Kurdistan has been eager to exploit their natural resources and start exploring their region, previously ignored by past Iraqi regimes. Although very few oil companies ventured into Iraqi Kurdistan early on the oil rush there began in earnest when it became clear that Baghdad was not going to manage to pass the oil and gas law any time soon.

The government of Iraqi Kurdistan introduced their own version of an oil and gas law and by doing so, managed to attract international oil companies into their region. The Kurdish made a conscious effort to go it alone and they carefully chose their own policy. However this inevitably led to conflict with Baghdad, with Iraq's federal government declaring the Kurdish law void and threatening to blacklist any international companies signing contracts with the Kurdish.

These kinds of policies, along with withholding oil payouts, has created more hard feelings and led to more of a deadlock on stalled oil legislation. At some levels Baghdad's policy has worked; it has deterred major oil companies and starved smaller oil companies of cash. However the policy unravelled somewhat when Exxon Mobil signed a deal with Iraqi Kurdistan in November 2011.

This was a watershed moment for the Kurdish and a blow to the al-Maliki administration. It challenged the Iraq's policy of black listing as Exxon already had a large stake in an Iraqi oil field in the south, West Qurna Phase 1.

Oil Contracts
Iraqis mistrust Western oil companies. Early on, after the fall of Saddam Hussein, the Iraqi people were sold this idea that the Western oil companies were there to ransack the country and take Iraq's oil for next to nothing, as was the case early last century. They believed this because in the past they had seen their oil flowing through the hands of foreign oil companies without seeing any actual benefit from it.

In 1928, four major oil companies - BP, Shell, Exxon Mobil and Total - formalised the Iraq Petroleum Company, previously known as the Turkish Petroleum Company, and gave themselves almost a quarter of the share of the profits each. A small royalty was paid to Iraq and for nearly 40 years, Iraq's oil was under the control of others before the oil industry was nationalised by Saddam Hussein's regime in1972.

The nationalisation of the oil industry was supposed to benefit the Iraqi people. But instead revenues were used to enter a mindless war with Iran and then later used to prop up Hussein's dictatorship and to suppress any dissenting voices inside Iraq.

Today, deciding which kinds of contracts international oil companies, that want to work in Iraq, should be awarded is not straight forward. In the early days, post the 2003 US-led invasion of Iraq that toppled Hussein, Western diplomats and international oil companies were lobbying Iraqi politicians for better terms and for the awarding of production sharing contracts. Meanwhile others warned against awarding contracts that were too lucrative and against giving too much oil away.

That latter argument won at the time as anti-Western fervour was whipped up and the Iraqi people believed that it was all about the theft of their oil wealth by internationals.

The best examples of such contracts can be found in Iraq's southern oil fields, where contracts went to the likes of BP, Exxon Mobil and Shell, among other major operators. In most cases, the service contracts paid the oil companies around US$2 per barrel of oil. This did not go down well with the large oil companies, who knew they would need to invest significantly in Iraq's oil industry in order to be able to produce the barrels of oil. These kinds of contracts may work in countries like the United Arab Emirates, where oil industry infrastructure is already in place and where less investment is required from the oil companies, but they cause concern in a country like Iraq.

The current policy of pressuring the international oil companies may be seen as a good move in the long term - it means that the Iraqi government gets the lion's share of oil revenues. But in the short term the cost to Iraq has been high, simply because it has taken nearly nine years to get the projects going and create the revenues needed to rebuild the country. And it remains to be seen whether these contracts will stand the test of time.

Recently it seems that some oil companies are looking for a way out of Iraq. In early February, it emerged that Norway's Statoil wants to sell its stake in the southern Iraqi West Quran Phase 2 field to Russia's Lukoil, also operating there.

Reuters reported that "the Norwegian state company has considered quitting Iraq for some time and turning its attention to less-risky assets elsewhere, industry sources said. It is planning billions of dollars worth of investments in areas such as offshore Norway and in the United States."

Additionally, events like Exxon Mobil's defiance of the Iraqi government in signing a contract with Iraqi Kurdistan is a sign that the oil company cannot be that worried about losing its contract in the West Qurna Phase 1 field.

The hard line policy of pressuring international oil companies may have gone down well with the Iraqi public but it appears to be unravelling as the oil companies start to realise that the terms they were offered, and the financial incentives, are not worth the risk. In a role reversal, the Iraqi government now needs to woo international oil companies in order to meet its own production targets and to keep the nation's revenue streaming in.

And perhaps as a result of recent events, such as the Exxon contract with Iraqi Kurdistan, it seems that Baghdad is beginning to realise. By all accounts, the next lot of contracts being offered to international oil companies in March will be more financially attractive than previous ones.

Lack of Expertise
If Iraq had the expertise and the intellectual capacity to develop its own oil and gas sector, the Iraqi national oil company would have been able to carry out most of the infrastructure and capacity building, with the help of foreign contractors.

But ever since the oil industry was nationalised, the country has been losing expertise and know-how. This is a vital piece of the oil industry jigsaw and it is not something that can be built up overnight; even if the right policies were in place, it would take decades and billions of dollars.

So it is obvious: the expertise and technology that international oil companies possess is needed here, in order to contribute to a more prosperous Iraq.

What Next?
The fact that attracting international oil companies into Iraq will be an ongoing challenge is illustrated by the delay in the fourth round of bidding for oil contracts. The bidding was to take place in January but has been postponed until the end of May. The contract on offer is a sort of new, hybrid version of contract. Some have noted that the contract is something of a production sharing contract in disguise - and the contract is disguised because of the general Iraqi public's belief that a production sharing contract is selling out their oil to foreign owners.

However for the oil companies themselves, if they are risking their money and going looking for oil, they find it difficult to quantify risks. Even if they did find oil, there's no guarantee that Iraq's infrastructure would be ready to help them begin pumping the oil out - especially given Baghdad's poor past record for completing projects and building capacity.

In conclusion then, Iraq has had grand plans for its own oil industry as well as ambitions for the power and influence that its oil could give it upon the world stage. However procrastination and misguided thinking about the oil industry's most chronic problems seem to have made these ambitions impossible.

Political power struggles have set the industry back and there doesn't seem to be any sign that the jostling for position will end soon. The fact that some oil companies are no longer sure if they even want to stay in Iraq can only be a testament to the fact that, after nine years, Iraq's oil policy has failed and that a change of direction is needed.